Exchange Rates, Investments and Income Tax

The disposition of capital property by an individual investor will generally result in a capital or loss.  Commonly individuals will convert funds into U.S. dollars to travel or for investment purposes.  Any gain or loss on the foreign exchange is normally treated as a capital gain.  There is a general exclusion of $200 on the gross amount of the gain or loss and ½ half of the net gain is included in taxable income for the tax year.

Investors with accounts in both Canadian dollars and U.S. dollar may wonder how the foreign exchange impacts their investments. 

Funds on Deposit

A individual taxpayer (who is not a speculator or business acquiring foreign funds for business purchases) deposits Canadian funds to a U.S. dollar account and at a later date converts the funds back into Canadian dollars for a gain will incur a taxable capital gain.  For individuals the first $200 of the (gross) gain is excluded.

Example:

Jan 1, 20X1: An individual taxpayer deposits $130,000 Canadian dollars to a U.S. dollar brokerage account at a rate of $1USD = $1.30CDN. 

Dec 31, 20X1: The funds are converted back into Canadian dollars at a rate of $1USD = $1.40CDN.

There will be a taxable capital gain of:

$4,900 = ½ x {[$130,000 x ($1.40 - $1.30)] – $200}

The same rules and $200 exclusion also apply to capital losses.

Transactions in Securities

The $200 exclusion on foreign exchange transaction does not apply to the acquisition and disposition of securities denominated in foreign currencies.  The acquisition and disposition of securities must be converted into Canadian dollars at the rate in effect at the time the transaction took place for the purposes of determining the capital gain or loss.

The following example shows the application of foreign exchange gains and losses as they relate to the acquisition of securities.

Jan 1, 20X1 – An individual taxpayer deposits $130,000 CDN into a U.S. dollar account at a rate of $1USD =  $1.30CDN.

May 1, 20X1 – The individual taxpayer purchases 10,000 shares of Amerco Ltd. at $10 USD per share from the U.S. dollar account.  The rate in effect at the time of the purchase was $1USD = $1.32 CAD

Dec 15, 20X5 – The individual taxpayer sells 10,000 shares of Amerco Ltd. at $20 USD per share.  The rate in effect at the time of the sale was $1USD = $1.35 CAD

June 30, 20X6 – The funds from the U.S. dollar account are transferred back into a Canadian dollar account.  The rate in effect at the time of the purchase was $1USD = $1.40 CAD

Tax Implications

May 1, 20×1: There is a foreign currency gain of $2,000 CDN = [($1.32 - $1.30) x $100,000.  The taxable amount of the gain included in income in 20X1 is:

$900 = [($2,000 - $200) x ½]

The adjusted cost base of Amerco Ltd. shares is $132,000 CDN = ($10 x 10,000 x $1.32)

Dec 15, 20X5: There is a taxable capital gain of $69,000CDN in 20X5 calculated as follows:

Proceeds of disposition: $270,000 = ($20 x 10,000 x $1.35)

Adjusted cost base: $132,000 = ($10 x 10,000 x $1.32)

Taxable capital gain:  $69,000 = [½ x ($270,000 - $132,000)]

The proceeds in the U.S. dollar account following the sale is $200,000 USD and the rate in effect is $1.35.

June 30, 20X6: There is a foreign currency gain of $10,000 CDN = [($1.40 - $1.35) x $200,000].  The taxable amount of the gain included in income in 20X6 is:

$4,900 = [($10,000 - $200) x ½]

Note: Theis post was updated March 2011.

Open a Questrade account today and get a $50 commission rebate. Use the offer code: taxresource

Related Articles

• Trading Stocks And Income Tax
• After Tax Returns & Your Investments
• Save Foreign Exchange By Washing Trades
• Capital Gains & Losses On Money Market Funds